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Overview of IFRS 2 Standard: Share-based Payment

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“Share-based Payment,” covered by IFRS 2 Standard, is one of the important International Financial Reporting Standards (IFRS) that addresses how companies should account for transactions where they pay for goods or services (including employee services) by issuing shares or other equity instruments, or by incurring liabilities whose value is based on the price of the company’s shares or other equity instruments. In this article, we will provide an overview of IFRS 2 Standard, discuss its scope, objectives, and key requirements, as well as explain how to measure and recognize share-based payments, and their impact on the financial statements.

What are Share-based Payments?

Share-based payments are transactions in which an entity receives goods or services in exchange for issuing equity instruments (such as shares or stock options) or incurs liabilities whose value is based on the price of the entity’s shares or other equity instruments.

Examples of Share-based Payments:

  • Stock Options: Grant employees the right to purchase company shares at a specified price during a specified period.
  • Employee Stock Purchase Plans: Allow employees to purchase company shares at a discounted price.
  • Restricted Stock: Shares granted to employees, but with restrictions on their ability to sell or transfer ownership.
  • Restricted Stock Units (RSUs): Virtual units that represent a promise by the company to grant the employee a specified number of shares in the future, usually after certain conditions are met.
  • Stock Appreciation Rights (SARs): Grant employees the right to receive a cash amount equal to the difference between the share price at the grant date and its price at a specified future date.

Scope of IFRS 2 Standard Share-based Payment:

IFRS 2 Standard applies to all share-based payment transactions, including:

  • Transactions with employees (such as employee incentive plans).
  • Transactions with non-employees (such as suppliers and consultants).

IFRS 2 Standard excludes from its scope:

  • Transactions in which goods are acquired as part of the net assets acquired in a business combination (these are addressed by IFRS 3).
  • Transactions that are considered the entity’s own equity instruments (such as the issuance of treasury shares).

Objectives of IFRS 2 Standard Share-based Payment:

  • Ensure Recognition of All Share-based Payment Transactions in the Financial Statements: IFRS 2 Standard aims to reflect the fair value of goods or services received by the entity in exchange for issuing equity instruments or incurring liabilities linked to its shares.
  • Provide Relevant and Reliable Information on the Impact of Share-based Payment Transactions: IFRS 2 helps users of financial statements understand the impact of these transactions on the entity’s financial position and performance.
  • Enhance Comparability: IFRS 2 Standard contributes to improving the comparability of financial statements of companies that engage in share-based payment transactions.
  • Improve Transparency: IFRS 2 Standard enhances the transparency of financial reporting by disclosing details of share-based payment transactions.

Measurement and Recognition of Share-based Payments:

IFRS 2 requires measuring share-based payments at fair value at the grant date (the date on which the agreement between the entity and the other party (such as an employee) on the terms of the share-based payment is reached).

The method of recognizing the expense of share-based payments differs depending on the type of transaction:

  • Equity-Settled Transactions: The goods or services received, and the corresponding increase in equity, are recognized over the vesting period (the period during which the other party (such as an employee) must provide services to become entitled to the equity instruments).
  • Cash-Settled Transactions: The goods or services received, and the corresponding liability, are recognized over the vesting period. The liability is remeasured at fair value at the end of each reporting period until it is settled.
  • Transactions with a Choice of Settlement: If the entity or the other party has the choice of settling the transaction in cash or by issuing equity instruments, the entity must account for that transaction as either a cash-settled transaction or an equity-settled transaction, based on the terms of the transaction.

Example of Accounting Treatment for Share-based Payments:

Scenario: Company “A” grants an employee 1,000 stock options on January 1, 2023. The stock options vest after 3 years (vesting period). The fair value of each option at the grant date is 10 Riyals.

Accounting Treatment (Equity-Settled Transaction):

  • Total Compensation Expense: 1,000 options × 10 Riyals = 10,000 Riyals
  • Annual Compensation Expense: 10,000 Riyals / 3 years = 3,333.33 Riyals (approximately)

Journal Entries:

At the end of each year of the vesting period:

  • Dr. Employee Compensation Expense (Debit) 3,333.33 Riyals
  • Cr. Equity – Stock Options (Credit) 3,333.33 Riyals

Impact of IFRS 2 on Financial Statements:

  • Income Statement: The expense of share-based payments is recognized in the Income Statement over the vesting period, affecting net profit.
  • Statement of Financial Position (Balance Sheet):
    • Equity-settled transactions: An increase in equity is shown.
    • Cash-settled transactions: A liability is shown on the liabilities side.
  • Statement of Cash Flows: Share-based payments settled in equity do not affect the statement of cash flows. Cash-settled share-based payments are shown within operating activities.

Disclosures Required by IFRS 2:

IFRS 2 requires companies to provide comprehensive disclosures about share-based payments, including:

  • A description of the share-based payment plans, including the terms and conditions of each plan.
  • The number and types of equity instruments granted, modified, canceled, and outstanding during the period.
  • The fair value at the grant date of equity instruments granted during the period.
  • The method used to determine the fair value of equity instruments.
  • The expense of share-based payments recognized during the period.
  • The total carrying amount of liabilities arising from share-based payments at the end of the period.

Importance of IFRS 2 Standard for Companies:

IFRS 2 is an important standard for companies that offer share-based payments as a way to incentivize employees or pay suppliers. Applying this standard helps companies:

  • Comply with International Financial Reporting Standards: IFRS 2 Standard ensures that companies treat share-based payments consistently with IFRS.
  • Improve the Quality of Financial Reporting: Applying IFRS 2 Standard improves the quality and transparency of financial information related to share-based payments.
  • Enhance Investor Confidence: IFRS 2 helps build investor confidence by providing more accurate and reliable information about the cost of share-based payments.
  • Better Manage Compensation Programs: IFRS 2 Standard provides a clear accounting framework for share-based payment programs, helping companies design and manage these programs more effectively.

Challenges in Applying IFRS 2:

  • Determining Fair Value: It can be difficult to determine the fair value of equity instruments, especially in unlisted companies.
  • Complexity of the Standard: IFRS 2 Standard is a relatively complex standard, and understanding and applying it may require specialized accounting expertise.
  • Estimating Forfeiture Rates: In the case of stock options, it can be difficult to estimate the number of employees who will leave the company before the options vest.

Role of Technology in Applying IFRS 2 Standard:

Accounting software and Enterprise Resource Planning (ERP) systems help in applying IFRS 2 Standard more efficiently and accurately by:

  • Automating the calculation of share-based payment expenses.
  • Tracking granted and outstanding equity instruments.
  • Performing complex calculations to determine fair value.
  • Generating reports necessary to comply with disclosure requirements.

Example (Advanced):

Company “B” grants 1,000 Restricted Stock Units (RSUs) to an employee on January 1, 2023. These units vest over 4 years. The fair value of a restricted stock unit at the grant date is 15 Riyals.

Accounting Treatment:

  • Total Compensation Expense: 1,000 units × 15 Riyals = 15,000 Riyals
  • Annual Compensation Expense: 15,000 Riyals / 4 years = 3,750 Riyals

Journal Entries: At the end of each year of the vesting period:

  • Dr. Employee Compensation Expense (Debit) 3,750 Riyals
  • Cr. Equity – Restricted Stock Units (Credit) 3,750 Riyals

Important Note: For a deeper understanding of International Financial Reporting Standards in general, you can refer to resources on IFRS. (Removed external link placeholder)

Conclusion:

IFRS 2 provides a comprehensive framework for accounting for share-based payments, helping to improve the quality and transparency of financial reporting. Companies that apply IFRS 2 Standard must comply with the requirements of this standard to ensure that these transactions are recognized, measured, and disclosed correctly. Understanding IFRS 2 Standard is essential for accountants, auditors, investors, and anyone interested in analyzing the financial statements of companies that offer share-based payments. With the increasing use of share-based payments as a tool to incentivize employees, the importance of IFRS 2 Standard is growing.

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